The SEC staff has granted no-action relief to allow index funds to become non-diversified as a result of market changes to the underlying index components. Without the relief, an index fund that tracks a third-party index would have to obtain shareholder approval to change its status from diversified to non-diversified when certain underlying component securities increased in value such that they would make up more than 5% of the portfolio. The relief would require prospectus disclosure that the fund could become non-diversified during these periods. The fund would still be constrained by the diversification requirements of the tax code and the applicable exchange on which it is traded.
This issue has dogged large index funds and ETFs for the last couple of years as the FAANG securities have increased in market value as compared to other index components. This letter offers welcome relief.